Indonesia economy: Minimum wages made easy

One of the less discussed reforms of the president, Joko Widodo (known as Jokowi), is the introduction of a simple index system to set minimum wages across the country. His system bypasses months of uncertainty and impassioned negotiation between labour unions and employer boards and instead links wage adjustments to inflation. Consequently, in October the manpower minister, Hanif Dhakiri, recommended an 8% average increase for 2019 minimum wages across the 34 provinces (consumer price inflation of 2.9% + GDP growth of 5.1%). Jokowi's reform is a small but positive step towards simplifying Indonesia's labour market.

In 2015 Government Regulation 78 established a new and uniform method for setting the minimum wage in Indonesia. The governors of each province are to calculate the annual increase by multiplying the current minimum wage by the inflation rate and the annual GDP growth rate. This system was set up partly to move away from the strong double-digit increases in minimum wages across the country over the historical period, as well as to make the wage negotiation process more predictable. Steep wage increases had been the norm, particularly in 2012‑14, when consumer price inflation was also rising strongly. These made it difficult for existing businesses to keep pace with the cost of labour and dissuaded new businesses from setting up in Indonesia.

A balancing act

Maintaining a balance between wage increases and productivity gains proved difficult prior to the 2015 law. Unions took their cues from regional peers (such as China and Vietnam) that had faster pay increases, whereas the business association defended the steadiness of wages by arguing that labour productivity was comparatively lower in Indonesia. External factors and changes to government-administered prices made wage negotiations even more complicated. During periods of currency depreciation, industries reliant on imported raw materials, such as the textile and garment trades, would have to face higher production costs. Businesses would therefore be more averse to wage increases that would inflate their costs even further.

Similarly, when successive governments sought to improve the fiscal position by reducing spending on fuel subsidies, workers' unions would press for the resulting higher cost of living to be reflected in higher wages. Workers would often organise strikes to push forward their demands. This resulted in protracted and sometimes fractious wage negotiations between firms and workers. The reforms to the labour laws will allow wages to increase more in sync with improvements in productivity. For example, in Jakarta, the capital and the wealthiest of Indonesia's 34 provinces, wage inflation has been cooling after years of successive double-digit annual increases. From a steep 44% minimum-wage increase for its residents, sanctioned by Jokowi (the then-governor of Jakarta) for 2013, the current administration led by Jokowi has authorised an increment of 8% for 2019.

Labour market unbalanced

Statutory minimum wages do not reflect the actual condition of the vast majority of the workforce. Indonesia has a population of about 260m, making it by far the largest labour force and domestic market in South-east Asia. The unemployment rate has been trending downwards, with data from Statistics Indonesia (BPS) showing that the unemployment rate stood at 5.3% in the third quarter of 2018, from a peak of 6.2% in the third quarter of 2015. However, beyond the falling unemployment rate in the formal sector, there exists a vast and underproductive informal sector, in which wages are usually lower than the statutory minimum. The number of workers migrating from casual work in the informal economy to more productive and better protected formal employment is rising in both absolute and relative terms. This has taken place as surplus labour from the agricultural sector transitions to higher-value manufacturing and, to a greater extent, services in fast-growing towns and cities. But the transfer to formal employment is happening slowly—the proportion of regular employees in the workforce increased from 34.9% in 2011 to 38.6% in 2015 (latest available data), indicating the creation of 8.8m formal jobs in five years.

The variation of wages across sectors is relatively high. Pay increases for casual workers in semi-skilled trades are not keeping pace with above-inflation raises for formal employees. Workers employed in the mining sector earn more than double the wages of those employed in agriculture. Data from BPS show that farmers working on a daily-wage basis received Rp48,368 (US$3.34) a day in October 2016 and Rp52,828 (US$3.65) in October 2018, a nominal average annual increase of 4.1%. Construction workers took home Rp83,057 a day in October 2016 and Rp86,717 a day in October 2018, which is an average annual increment of only 2.1% and actually a pay cut in real terms. A 2016 labour force survey indicates an average gender pay gap of around 20%, which shoots up to 45% in agriculture, a major employer in poorer, rural areas.

Education matters

Continued improvement in education outcomes is paramount if Indonesia is to expand the workforce before its population begins to age. Men who finished high school earned an average Rp2.5m (US$172.9) annually in 2016, which was 59.8% more than those with primary education or less. For women, the situation remains worse and a solution is needed urgently. Women with high school education earned on average Rp1.9m in 2016, while those who did not complete primary education earned only Rp900,000 (US$62.2) per year. Jokowi is increasingly spending on regional vocational education, but government labour surveys from 2006‑16 show that the proportion of Indonesians under the age of 34 with insufficient education for their job doubled in a decade. This indicates a problem in closing Indonesia's skills gap and poses a downside risk for rising wages in the longer term.